Limited scope for housing market recovery - Capital Economics
UK Housing

Limited scope for housing market recovery

UK Housing Market Outlook
Written by Andrew Burrell
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Regardless of what happens with Brexit in the months ahead, a revival in the owner occupier housing market is unlikely. Even if a Brexit deal is agreed soon, we expect to see only a small improvement in housing market transactions and house price growth over the next two years. That said, the outlook for the rental market is stronger, as weak lettings supply and solid wage growth push rental growth higher.

  • Overview – Regardless of what happens with Brexit in the months ahead, a revival in the owner occupier housing market is unlikely. Even if a Brexit deal is agreed soon, we expect to see only a small improvement in housing market transactions and house price growth over the next two years. That said, the outlook for the rental market is stronger, as weak lettings supply and solid wage growth push rental growth higher.
  • The Economic Backdrop – With the political backdrop highly uncertain, we continue to present three forecasts – a Brexit deal, a no deal Brexit and a scenario where Brexit is repeatedly delayed. If the Brexit deal agreed between the UK and the EU passes through Parliament, GDP growth, interest rates and the pound may all rise by more than is widely expected. But without a deal, the upside for the UK economy is limited.
  • Valuation and Affordability – Sluggish house price growth is driving a stealthy improvement in valuations, which we expect to continue across our forecast. And while mortgage affordability will remain favourable, regardless of what happens with Brexit, there are nonetheless many reasons why housing is overvalued.
  • The Mortgage Market and Completed Sales – Mortgage approvals have held steady this year, but the transactions data are more downbeat. Looking ahead, high house prices and a lack of homes for sale will keep transactions growth weak. So even if a Brexit deal is agreed, the upside for mortgage approvals and transactions is fairly limited.
  • House Prices – While house price growth has faltered, a house price collapse is still unlikely – even if a no deal Brexit were to happen. That said, prices will also struggle to gain much upward momentum, regardless of what happens with Brexit, as mortgage interest rates will struggle to fall further, while regulation continues to restrict the availability of high-LTI lending.
  • The Regional Outlook – London’s fall in house prices will continue a little longer, even if a Brexit deal was agreed. And uncertainty has weighed on markets outside of London too. But in those markets, where house prices tend to be lower, a deal could bring about a gentle rise in house price growth – of up to 3% per year.
  • Residential Lettings Market – The rental market recovery stalled in Q3. But the imbalance between tenant demand and rental supply is likely to persist, meaning rental growth will strengthen in the medium term. That said, this will be of little comfort to landlords, as tax changes and weak capital growth leave returns subdued.
  • Housing Supply – London has been the key driver behind the decline in housebuilding. But construction has now dropped sharply in nearly every region. Given the drop already seen in the first half of the year, the outlook for housing starts in 2019 is weak. But assuming a Brexit deal is agreed soon, we expect a more limited decline beyond that.

Main Forecasts

Table 1: Housing Market Forecasts (Brexit Deal Scenario)

2018

2019

2020

2021

House prices, transactions and the economy

Nationwide house prices (Q4 on Q4)

£000s

213.4

215.6

218.8

223.2

% y/y

0.5

1.0

1.5

2.0

Completed transactions

mn

1.19

1.19

1.20

1.23

% y/y

-2.7

-0.3

0.8

3.0

Employment

% y/y

1.2

1.0

0.6

0.5

ILO Unemployment rate

%

4.1

3.9

3.8

3.8

Average earnings (inc. bonuses)

% y/y

2.9

3.7

3.6

3.5

Real h’hold disposable income

% y/y

2.2

2.3

1.8

1.8

Headline CPI Inflation

% y/y

2.5

1.9

2.1

2.0

Real Household spending

% y/y

1.6

1.2

1.8

1.9

Real GDP

% y/y

1.4

1.3

1.5

2.2

Affordability & valuation (year-end)

Mortgage affordability

%

36.6

36.2

37.0

39.0

(payments as % of take-home pay)

House price-to-earnings ratio

7.0

6.8

6.7

6.6

Bank Rate

%

0.75

0.75

1.00

1.50

Mortgage Interest Rate

%

2.15

2.25

2.40

2.55

Mortgage lending

Mortgage Approvals – Total

000s

1,534

1,542

1,545

1,556

– for house purchase

000s

781

782

797

820

  for remortgage

000s

582

584

568

552

  other

000s

169

176

179

184

Gross mortgage advances

£bn

268

261

263

269

Net mortgage lending

£bn

44.2

44.1

43.4

40.1

Mortgage arrears (>2.5% of bal.)

% of loans

0.8

0.9

1.0

1.1

Possessions

% of loans

0.01

0.01

0.02

0.03

The rental market

BTL mortgage advances

000s

66.6

65.2

65.7

65.6

(for house purchase)

% of total

8.5

8.5

8.4

8.1

Rental value growth (year-end)

% y/y

1.0

1.5

2.5

3.5

Gross rental yields (year-end)

%

4.8

4.8

4.8

4.9

Net returns for housing (year-end)

%

1.0

1.6

1.9

2.4

Housing Supply

Housing starts

000s

170

160

157

155

% y/y

3.5

-5.9

-1.8

-1.3

Regional house prices (year-end)

London

% y/y

-0.9

-3.0

-1.0

0.0

South East

% y/y

-0.7

-1.0

0.0

0.0

East of England

% y/y

1.9

1.0

0.0

1.0

South West

% y/y

1.9

1.0

1.5

0.0

East Midlands

% y/y

4.0

1.5

3.0

3.0

West Midlands

% y/y

3.0

2.0

3.0

3.0

North East

% y/y

1.0

3.0

2.0

3.5

North West

% y/y

2.2

1.0

2.0

3.0

Yorkshire & the Humber

% y/y

3.7

2.0

2.5

3.5

Wales

% y/y

3.9

1.0

2.0

2.5

Scotland

% y/y

0.9

1.5

2.0

3.5

Northern Ireland

% y/y

5.9

2.5

3.0

3.5

Sources: Nationwide, Bank of England, MHCLG, UK Finance, ONS, Thomson Datastream, Capital Economics

Main Forecasts (continued)

Table 2: Selected Housing Market Forecasts (Repeated Delay Scenario)

2018

2019

2020

2021

Housing Market and Mortgage Lending

Nationwide house prices (Q4 on Q4)

£000s

213.4

215.6

218.8

223.2

% y/y

0.5

1.0

1.5

2.0

Completed transactions

mn

1.19

1.19

1.19

1.23

% y/y

-2.7

-0.3

0.8

3.0

Mortgage approvals for house purchase

000s

195

192

200

208

Mortgage Interest Rate

%

2.15

2.05

1.80

1.80

The Economy

ILO Unemployment rate

%

4.1

3.9

3.9

3.9

Average earnings (inc. bonuses)

% y/y

2.9

3.7

3.5

3.3

Headline CPI Inflation

% y/y

2.5

1.9

1.8

1.8

Real GDP

% y/y

1.4

1.3

1.0

1.5

Bank Rate

%

0.75

0.75

0.5

0.5

Sources: Nationwide, Bank of England, ONS, Refinitiv, Capital Economics

Table 3: Selected Housing Market Forecasts (No Deal Scenario)

2018

2019

2020

2021

Housing Market and Mortgage Lending

Nationwide house prices (Q4 on Q4)

£000s

213.4

213.4

212.4

216.6

% y/y

0.5

0.0

-0.5

2.0

Completed transactions

mn

1.19

1.17

1.13

1.21

% y/y

-2.7

-1.5

-3.5

7.3

Mortgage approvals for house purchase

000s

195

179

197

203

Mortgage Interest Rate

%

2.15

2.00

1.75

1.80

The Economy

ILO Unemployment rate

%

4.1

3.9

4.2

4.1

Average earnings (inc. bonuses)

% y/y

2.9

3.7

3.2

3.4

Headline CPI Inflation

% y/y

2.5

1.9

2.4

2.2

Real GDP

% y/y

1.4

1.1

0.0

2.0

Bank Rate

%

0.75

0.50

0.25

0.50

Sources: Nationwide, Bank of England, ONS, Refinitiv, Capital Economics


The Economic Backdrop

Brexit continues to shape the UK outlook

  • Even if the Brexit saga is resolved, weaker-than-expected global economic growth means the outlook for the UK economy has become gloomier. We now see little upside for GDP, interest rates and the pound over the next few years, unless a deal is agreed with the EU and ratified in UK Parliament.
  • With the political backdrop changing almost daily, we are still providing clients with three scenarios – a deal on 31st October, repeated delays, and a no deal on 31st October. At the time of writing, it is a very close call whether or not Parliament will pass Boris Johnson’s Brexit deal over the next few months. With the global outlook weak, we have revised down our forecasts in each of these three scenarios. (See Chart 1.)
  • While the economy contracted in Q2, the UK probably avoided a recession, as GDP growth looks set to reach 0.4% q/q in Q3. (See Chart 2.) Even so, the survey data still point to little upward momentum in the economy. (See Chart 3.)
  • That said, we still think a recession would occur in only one scenario – where the UK exits the EU with no deal. Then again, the effect is also uncertain, with a wide range of outcomes depending on the policy response. (See Chart 4.)
  • Overall, we think GDP would fall by 1.0% in the first two quarters under no deal. However, interest rates would likely be cut almost immediately, falling from 0.75% now to 0.25% in mid-2020. What’s more, we expect a fiscal stimulus equivalent to 2% of GDP. This policy response means any recession would be short and shallow by historical standards. (See Chart 5.) If that’s the case, growth would rebound to over 2% by 2021.
  • Meanwhile, if Brexit is repeatedly delayed, we think that prolonged uncertainty would keep a lid on spending by both businesses and households. In turn, GDP will probably ease from 1.3% in 2019 to just 1.0% in 2020. And we doubt inflation will rise above the 2% target, leaving the door open for interest rate cuts. We expect a 25bps cut in mid-2020, from 0.75% to 0.50%. (See Chart 6.)
  • What’s more, it looks as though any delay would be followed by a general election. That would determine whether the economy would need to deal with the less business friendly policies of a Labour government.
  • Of course, if a deal is agreed soon, it could revive the economy after its recent weak patch. In that scenario, a rebound in investment would drive GDP growth to 1.5% in 2020 and to 2.2% in 2021. And the Bank of England would probably strike out on its own and hike rates, most likely from 0.75% to 1.50% by end-2021.
  • In terms of the labour market, Brexit uncertainty has made investing in capital less appealing than hiring workers. (See Chart 7.) However, if there is a Brexit deal, this will probably reverse. Employment growth would most likely halve from around 1.2% this year to 0.6% in 2020, although the unemployment rate would probably stay unchanged.
  • Assuming a no deal is avoided, a tight labour market would keep average pay growth above 3% y/y. And even if there is a no deal, we only expect a mild dip, from 3.7% y/y in 2019 to 3.2% y/y in 2020. (See Chart 8.)

The Economic Backdrop

Chart 1: Real GDP in Different Brexit Outcomes (% y/y)

Chart 2: Real GDP

Chart 3: Activity PMIs

Chart 4: GDP in Different No Deal Outcomes (% y/y)

Chart 5: Change in Real GDP During Recessions (%)

Chart 6: Bank Rate (%)

Chart 7: Employment & Business Investment (%y/y)

Chart 8: Average Weekly Earnings (3m av. of % y/y)

Sources: ONS, Refinitiv, IHS Markit/CIPS, Capital Economics


Valuation and Affordability

A stealthy improvement in valuations

  • House price growth was sluggish across the third quarter. The Nationwide index recorded prices rising at just 0.2 y/y in September, while the refreshed Halifax index recorded growth of 1.1% y/y. (See Chart 9.) That slow rate of price growth is driving a stealthy improvement in valuations, which we expect to continue over the next few years.
  • In real terms, house prices have been falling, as inflation stood at 1.7% in September – significantly faster than nominal house price growth. (See Chart 10.). As a result, real house prices have now dipped below a level consistent with their long-run trend growth rate, of 2.25% y/y.
  • Looking ahead, we think that trend growth in real house prices is unlikely to be sustained. One of the key factors supporting the current, high level of house prices is the structural decline in interest rates. Mortgage interest rates have fallen from around 9% in the 1970s and 80s, to just 2% in the latest data. (See Chart 11.) Consequently, house prices have risen to a very high level, but mortgage affordability has stayed on a fairly sustainable footing. (See Chart 12.)
  • But mortgage interest rates are now at, or close to their floor, meaning the force that enabled the sustained rise in real house prices has now been expended. Looking ahead, we expect the fundamentals to support only limited growth in real house prices.
  • Furthermore, the relatively low level of initial mortgage payments hides changes in the long-run cost of housing. Chart 13 shows how average affordability during the first 15 years of a mortgage has changed over the last few decades. This calculation includes projections beyond our forecast horizon in line with our long-run views on wages, interest rates and house price growth.
  • This shows that, while low interest rates have kept initial mortgage affordability favourable compared to what borrowers faced in the past, that benefit sharinks over the course of the loan. That reflects our view that mortgage interest rates are unlikely to see another sustained decline, while low inflation will keep nominal wage growth lower than typically seen in the past.
  • That suggests homes may be overvalued despite the fall in mortgage interest rates. Consistent with that, commercial property capital values have underperformed residential property, even though interest rates have fallen for both. And house prices are also high relative to rents. (See Chart 14.)
  • Of course, a key consideration is the outcome of Brexit, which is still highly uncertain. If a deal is approved soon, we expect the improving economic backdrop to prompt a few rate hikes over the next few years. (See Chart 15.) But the rise in mortgage interest rates will largely be offset by a falling house price to earnings ratio, which will keep mortgage affordability favourable, despite higher interest rates. (See Chart 16.)
  • If Brexit is delayed for longer than a few months, the recovery in economic growth and rise in mortgage interest rates would be delayed too. The effect on mortgage affordability would be limited. And in the event of a no deal Brexit, which still cannot definitively be ruled out, the resulting interest rate cut would drive a small improvement in mortgage affordability – providing a little support to housing valuations and helping to prevent a collapse in house prices.

Valuation and Affordability

Chart 9: House Prices (£000s)

Chart 10: Real House Prices

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Chart 11: Long Run Mortgage Interest Rate (%)

Chart 12: Mortgage Affordability and House Price to Earnings Ratio

Chart 13: Average Mortgage Affordability over the Lifetime of a 15-Year Loan

Chart 14: House Price to Rent Ratio

Chart 15: Mortgage Interest Rate Forecast (%)

Chart 16: Mortgage Interest Rate and House Price to Earnings Ratio (%, Brexit Deal Scenario)

Sources: Nationwide, ONS, UK Finance, Refinitiv, Capital Economics


The Mortgage Market and Completed Sales

Limited improvement if Brexit deal is agreed

  • House purchase mortgage approvals continue to hover in the 62,000 to 72,000 loans per month range seen since 2013. (See Chart 17.) If a Brexit deal is agreed, housing market activity could see a sustained, albeit modest, rise over the next few years – putting mortgage approvals towards the top of that range.
  • Admittedly, the transactions data have been particularly volatile in recent months. (See Chart 18.) A sharp fall was recorded in June, but was subsequently revised away. The most recent data suggest that transactions have held mostly flat in recent months.
  • In the near term, RICS surveyors have been reporting falling newly agreed sales – consistent with a shrinking pipeline of in-progress housing transactions. Of course, the relationship between surveyors’ reports and the hard data are far from perfect. (See Chart 19.) Nonetheless, as a leading indicator, it suggests that housing transactions will stay flat or fall over the next few months.
  • Given the high level of house prices, combined with the lack of homes for sale, a weak near-term outlook for transactions is not surprising. (See Chart 20.) And on a longer horizon, with the house price to earnings ratio set to stay high compared to past norms, high house prices are likely to continue to weigh on housing market activity.
  • That said, it is likely that, if Brexit uncertainty were to soon ease, activity could see some limited improvement.
  • For one, mortgage interest rates are currently very low, underpinning housing demand. Even if a Brexit deal is agreed soon, mortgage interest rates are likely to stay below 3% for the next few years – a very low level compared to past norms.
  • Furthermore, underlying competition between lenders is strong. While the latest credit conditions survey reported a small decline in overall availability in Q3 2019, that was driven mainly by a weak economic outlook, risk aversion and house price expectations. (See Chart 21.) If a Brexit deal were to be agreed soon, those negative drivers would ease, potentially boosting credit availability.
  • Then again, mortgage interest rates are unlikely to fall much further. Our calculations show that lenders have already pushed their interest margin to within 50 basis points of the 2004 to 2006 level. (See Chart 22.)
  • But a reprieve from Brexit uncertainty is also likely to boost demand, bringing wary buyers and sellers back into the housing market. That could finally spur a rise in lending and transactions.
  • If a Brexit deal is agreed soon, mortgage approvals could grow by around 5% by 2021 – a substantial improvement on stagnant result we have pencilled in for 2019. (See Chart 23.) And we think transactions would rise by around 3%. (See Chart 24.)
  • If Brexit is delayed longer than a few weeks or months, that recovery would be delayed alongside it. In that event, we suspect that activity would probably hold broadly in line with its current level, rather than rise.
  • Meanwhile, a no-deal Brexit cannot yet be ruled out. In such an event, we think the sharp pick-up in uncertainty would discourage a large number of prospective buyers from the market. Mortgage approvals for house purchase and housing transactions could immediately drop by 10% or so. But we think activity would bounce back fairly quickly.

The Mortgage Market and Completed Sales

Chart 17: Mortgage Approvals for House Purchase

Chart 18: Housing Transactions by Month of Release
(000s per Month)

Chart 19: Newly Agreed Sales and Transactions

Chart 20: Unsold Stock per Surveyor

Chart 21: Availability of Credit and the Factors Affecting Availability (% Balance)

Chart 22: Mortgage Lenders’ Interest Margin (%)

Chart 23: House Purchase Mortgage Approvals Forecasts
(000s per Qtr)

Chart 24: Transactions Forecasts
(000s per Qtr)

Sources: RICS, Bank of England, Refinitiv, Capital Economics

The Mortgage Market and Completed Sales (continued)

Rise in first time buyer lending ahead

  • Mortgage advances to first-time buyers (FTBs) have performed better than lending to movers. But overall, both categories have disappointed. (See Chart 25.) Looking ahead, the prospects for FTB lending are a little stronger than for movers, while no recovery in buy-to-let (BTL) activity is expected.
  • The relative strength of FTB lending partly reflects falling high-LTV pricing. Cheaper low deposit mortgages enable house purchase among deposit -constrained buyers. (See Chart 26.) Data from the Bank of England suggest that the proportion of new loans with an LTV of between 90% and 95% stood at 5.2% in Q2 2019. That was a modest rise, up from the 3.6% seen a year earlier.
  • Admittedly, it is hard to know how many of these additional high-LTV borrowers were FTBs, and how many were movers. But given the timing of the changes, cheaper high-LTV lending has probably contributed, at least in part, to the relative strength of FTB mortgage advances.
  • We wouldn’t want to overemphasize the recent improvement in credit availability though. While high-LTV pricing has fallen, lenders have largely held back from loosening credit standards. (See Chart 27.)
  • Taking a step back, the bigger picture is that conditions have shifted in favour of owner occupiers. (See Chart 28.) This reflects FTBs benefitting from weaker investor activity – making it easier to gain a foothold in the property market.
  • Looking ahead, these tax changes are unlikely to be reversed anytime soon – supporting FTB lending. Assuming a Brexit deal is agreed soon, we expect to see around 359,000 FTB mortgage advances in 2019, rising by around 6.5% to around 382,000 in 2021. (See Chart 29.) Meanwhile, we think home mover advances will see a more modest rise, from 349,000 loans in 2019, and 368,000 loans by 2021.
  • The pick-up in FTB mortgage share will come at the expense of BTL. The 65,600 buy-to-let advances we have forecast in 2021 will be well below the average of 106,700 loans per-year seen between 2014 and 2016.
  • Borrowers can still benefit strongly from refinancing. New mortgages were, on average, 36 basis points cheaper than existing mortgages in August. (See Chart 30.) And the average standard variable rate held firm at at 4.3% in September, makes remortgaging at the end of a fixed-rate deal extremely likely.
  • That said, with five-year fixes having risen in popularity, the flow of borrowers coming off two-year fixed rate loans may already have peaked. As a result, we expect remortgaging volumes to end 2019 broadly flat compared to 2018. Beyond that, we expect the continued popularity of long fixes to reduce remortgaging volumes by 2.5% in 2020 and 3% in 2021.
  • If a Brexit deal is agreed in the coming months, we expect gross mortgage advances of £261bn in 2019, rising to £269bn by 2021. But net lending will edge down slightly, from £44bn in 2019, to £40bn in 2021 – driven by a rise in repayments as mortgage interest rates rise. Of course, longer delays to Brexit would delay a recovery in gross lending, while a no-deal Brexit could drive a sharp slump in lending.

The Mortgage Market and Completed Sales (continued)

Chart 25: Mortgage Advances by Buyer Type
(% y/y)

Chart 26: Average Quoted Interest Rate on a 95% LTV Fixed Rate Mortgage (%)

Chart 27: Lenders Reporting Looser Credit Criteria and a Higher Share of Loan Application Approvals (% Balance)

Chart 28: Annual Change in Stock of Mortgages by Type
(000s)

Chart 29: Mortgage Advances Forecast
(000s per Qtr, Brexit Deal Scenario)

Chart 30: Effective Rate on New Mortgage, Outstanding Mortgage and Average Quoted SVR

Chart 31: Remortgaging Approvals Forecast
(000s per Qtr, Brexit Deal Scenario)

Chart 32: Gross and Net Lending Forecasts
(£bn, 4q Rolling, Brexit Deal Scenario)

Sources: UK Finance, Bank of England, Refinitiv, Capital Economics


House Prices

Limited upside for house price growth

  • House Price growth stalled in Q3. The Nationwide index recorded prices growing at 0.2% y/y in September. (See Chart 33.) Meanwhile, the refreshed Halifax index recorded growth at a sluggish 1.1% y/y during the same month. Looking ahead, there is limited scope for house price inflation to pick up over the next two years.
  • The weakness in house price inflation is corroborated by other house price indices. According to the official index, prices rose by 1.3% y/y in August. (See Chart 34.) Meanwhile, the Acadametrics measure came in at minus 0.4% y/y in September, while Rightmove’s measure of asking prices recorded a 0.2% y/y fall in October.
  • Of course, given the uncertain political and economic environment, slowing house price growth is to be expected. Indeed, the very large drop in new buyer enquiries seen over the last year or so, on past form, suggests that house prices should have performed even worse. (See Chart 35.)
  • The resilience of prices to a broader decline probably reflects several factors. For one, low unemployment has kept the number of forced sellers low. Indeed, the number of arrears is very low compared to past norms.
  • Meanwhile, uncertainty has discouraged sellers and buyers alike. As a result, the very low stock of homes for sale has persisted – helping to keep market conditions tight. That can be seen in the measure of months of homes for sale, which has been rising. (See Chart 36.) On past form, that has been consistent with a much faster rate of house price growth than at present.
  • On balance, our outlook is for muted house price growth over the next few years. A major factor that has supported high house prices is the fall in mortgage interest rates seen over the last few decades. But further falls are unlikely, leaving prices unable to sustain a much faster rate of growth than at present.
  • Furthermore, mortgage regulations introduced in 2014 are restricting the ability of borrowers to take out high LTI loans – constraining housing demand further. These regulations are unlikely to be removed anytime soon.
  • Indeed, looking ahead, the regulations are designed so that rising interest rates will further restrict maximum LTIs. From around 5 times at present, a 1% rise in mortgage interest rates might cut the maximum LTI available to borrowers to around 4.5 times. (See Chart 37.)
  • But while house price growth is set to be weak, we think the likelihood of a collapse in house prices is low. It would take a very large interest rate hike for mortgage affordability to deteriorate enough to trigger a collapse in prices. Given the weak economic outlook, that seems unlikely. Indeed, in our Brexit deal scenario, where interest rates rise by 75bps from their current level, mortgage affordability still looks good by past norms. (See Chart 38.)
  • If a Brexit deal is done soon, we expect house price growth to accelerate only gently over the next few years – from 1% y/y in 2019, to 2% by 2021. (See Chart 39.) And a delay to Brexit would probably do little to change this. That will leave house prices climbing in nominal terms, but prices falling by a sizable degree in income-adjusted terms. (See Chart 40.)
  • That said, we don’t think prices would collapse under a no deal scenario. We think sellers would be able to wait out the storm, cutting transactions rather than prices – which might fall by a few percentage points at most.

House Prices

Chart 33: House Prices

Chart 34: Other Measures of House Prices

Chart 35: New Buyer Enquiries and House Prices

Chart 36: Months of Homes for Sale and Nationwide House Prices

Chart 37: Effect of Mortgage Affordability Test on Maximum LTI

Chart 38: Mortgage Affordability Forecast
(% y/y, Brexit Deal Scenario)

Chart 39: House Price Forecast
(% y/y, Brexit Deal Scenario)

Chart 40: House Price and HPE Forecast
(Brexit Deal Scenario)

Sources: Halifax, Nationwide, RICS, Refinitv, Capital Economics


The Regional Outlook

London price falls to moderate

  • London’s housing market has been in gentle decline. New buyer enquiries saw a brief rise in June and July, but demand subsequently fell in August and was flat in September. (See Chart 41.) New sales instructions have been falling for most of the last 18 months.
  • House price falls within London have been more prominent in the prime central boroughs, which saw a 7.7% y/y decline in August. (See Chart 42.) Meanwhile, prices in outer London fell by a modest 1.7%, while prices in non-prime central London edged up by 0.7% y/y.
  • Across the capital, the big picture is that prices have either been flat or falling gently, with the ratio of central London to outer London prices holding close to its long-run average. (See Chart 43.) Indeed, over the last few years, London prices have seen a modest cumulative fall – of 5.1% – since peaking in Q1 2017.
  • Looking ahead, we expect the decline in prices to ease. Part of that is down to wage growth. In wage adjusted terms, house prices have already fallen by a hefty 13.2% from their peak. Assuming a Brexit deal is agreed soon, wage growth is expected to run at above 3% a year across our forecast. That will significantly erode prices in wage-adjusted terms.
  • The modest decline in prices also reflects London’s strong economy, which has kept the number of forced sellers low. Combined with the unwillingness of current owners to accept lower prices, transactions in London have fallen instead, as buyers and sellers have remain locked in a stand-off. (See Chart 44.)
  • Indeed, there are some signs that sellers have become more patient, despite Brexit. Unsold stock per surveyor had risen from a low of 29 homes 2016 to a peak of 42 homes at the start of 2019 – signalling a build-up of properties that owners were struggling to shift. (See Chart 45.) But that figure has since declined, edging down to 36 homes in September 2019. With sales still weak, this means sellers have delisted their properties, rather than sell into the weak market.
  • Of course, this may only be building up trouble in the future. But on balance, assuming a no deal Brexit is avoided, a solid economy and easing uncertainty leaves our outlook for prices only moderately negative. Consistent with that, surveyors expect house prices in London to fall over the next three months, but see prices flat over the next 12. (See Chart 46.)
  • Assuming a Brexit deal is agreed soon, we think London house prices will fall by 3% in 2019 as a whole, followed by a 1% fall in 2020 as the market starts to stabilise. (See Chart 47.) By 2021, we think prices in London will be flat over the year.
  • In wage-adjusted terms, this represents a significant downward adjustment in prices. Indeed, falling house prices, combined with rising wages, will leave London’s house price-to-earnings ratio at 10.5 times in 2019 – down substantially from its peak of 13.4 times. (See Chart 48.) Mortgage affordability will also improve, as repayments as a percentage of income drop to a level comparable to what was seen in 2014.
  • Of course, other Brexit scenarios cannot entirely be ruled out. But unless the UK sees a sharp rise in unemployment or a spike in mortgage interest rates – which we do not expect a no-deal Brext to trigger – house prices in London are unlikely to collapse over the next few years.

The Regional Outlook

Chart 41: London New Buyer Enquiries and New Sales Instructions (% Balance)

Chart 42: London House Price Growth (% y/y)

Chart 43: Ratio of Outer London to Central London House Prices

Chart 44: London Transactions as a % of UK

Chart 45: London Unsold Stock per Surveyor

Chart 46: London House Price Expectations
(% Balance)

Chart 47: House Price Forecast
(% y/y, Brexit Deal Scenario)

Chart 48: London Mortgage Affordability and House Price to Earnings Ratio (Brexit Deal Scenario)

Sources: RICS, ONS, Nationwide, Refinitiv, Capital Economics

The Regional Outlook (Continued…)

A gradual regional convergence

  • Outside of London, regional housing markets have also slowed. Over the last three months, new buyer enquiries have fallen in every region except the North East and North West. (See Chart 49.) Meanwhile, new sales instructions have fallen in nearly every region except for Wales. (See Chart 50.)
  • Across the regions, there has been little correlation between the size of the fall in buyer enquiries or sales instructions, and housing valuations.
  • House price to earnings ratios are the highest in the South of England and the lowest in the North of England. (See Chart 51.) But that regional pattern is not evident in the activity data. For example, the Yorkshire & the Humber has a relatively low HPE ratio. But the region recorded the largest drop in new buyer enquiries over the last three months, suggesting that comparatively lower prices have done little to prop up active buyer demand.
  • As a result, it seems that much of the current weakness in activity across the regions reflects uncertainty. So once that uncertainty eases, there may be some limited scope for activity to rise once more.
  • Supporting that is the fact that the underlying regional economies are solid. Unemployment in every region is low level compared to past norms. (See Chart 52.) Moreover, the rise in wage growth on a national basis has been evenly distributed – with every region bar the North East recording wage growth exceeding 2% y/y on a four-quarter rolling basis in Q2.
  • Admittedly, in terms of house price growth, the South East struggled again in Q3 – with prices falling at 1.1% y/y. (See Chart 53.) That reflects high prices in the region, combined with London’s house price fall dragging down values in this neighbouring region.
  • Admittedly, there’s a good change that house price falls in the South East might not last. On past form, months of homes for sale is consistent with a small rise in house prices over the next few months. Yet, taking a longer view, the region is still displaying elevated stock levels, combined with falling transactions, which signals a build-up of unsold homes. (See Chart 54.) Even if house prices in the South East stop falling, the region is set to underperform.
  • Elsewhere, the data point to low levels of unsold stock and no substantive fall in transactions. This suggests that housing market conditions across much of the UK are still fairly tight. Of course, already high prices and low interest rates rule out a fresh house price boom. But assuming a Brexit deal is passed soon, there may be room for a small acceleration in regional house price growth.
  • Assuming this, we expect regional differences in house price growth to be driven mainly by the fundamentals. Regions in the North and Midlands, which have the lowest HPE ratios, will see house price grow by between 1% and 3% per year out to 2021. (See Chart 55.) Meanwhile, we think prices will rise by less than 1.5% y/y in the South of England over the same period.
  • Taking all that together, the next few years should see a gradual re-adjustment in regional house price to earnings ratios – narrowing the gap between the northern and southern regions. (See Chart 56.)

The Regional Outlook (Continued…)

Chart 49: Regional New Buyer Enquiries
(% Balance, 3m Average, Jul-Sep 2019)

Chart 50: Regional New Sales Instructions
(% Balance, 3m Average, Jul-Sep 2019)

Chart 51: Regional House Price to Earnings Ratio
(Q3 2019)

Chart 52: Unemployment Rate Percentage Points from Long-Run Average (%, August 2019)

Chart 53: South East Months of Unsold Stock and House Price Growth

Chart 54: Transactions and Stock Per Surveyor
(% Change, Jan 2015 to Q2 2019)

Chart 55: Regional House Price Growth Forecast
(% y/y)

Chart 56: Regional House Price to Earnings Ratio
Forecast (Brexit Deal Scenario)

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Sources: ONS, Nationwide, RICS, Capital Economics


Residential Lettings Market

Stall in rental growth will be temporary

  • The nascent recovery in the rental market stalled in Q3. According to IPHRP data, rental growth in England held steady at 1.3% y/y in September. (See Chart 57.) But with tighter supply and stronger tenant demand, we expect faster rent rises in the medium term.
  • Solid fundamentals have supported the rental market this year. For one, tenant demand has strengthened. RICS survey data pointed to a further increase in demand in Q3, helped by higher wages. (See Chart 58.) Indeed, average weekly earnings rose by 3.8% in August. Granted that was slower than in July, but pay growth is still within touching distance of its recent decade high. In turn, rents are now equivalent to just over 32% of the average post-tax income, compared to 33% last year. (See Chart 59.)
  • Looking ahead, while we think employment growth has probably peaked, the labour market should stay tight, keeping wage growth above 3% in the medium term. (See Chart 60.) Not only would strong pay growth directly support rental affordability, but it may also entice young adults to enter the rental market, moving from their parental homes.
  • Rental growth has also been supported by a tightening rental supply. Indeed, the RICS survey data recorded another fall in landlord instructions in Q3. That’s largely the result of tax changes which have made BTL less attractive, driving incumbent landlords away from the market while discouraging many from expanding their portfolios.
  • Looking ahead, we doubt the malaise in rental supply will improve anytime soon. For a start, further tax changes to BTL landlords are set to be phased in. And the economy is unlikely to offer much support either. Prolonged Brexit uncertainty has deterred investment. And while the likelihood of a Brexit deal has grown significantly, we doubt that will provide any respite. After all, a deal will be accompanied by interest rate hikes, making BTL investment less attractive.
  • A key driver of faster rent rises will be the ongoing recovery in London’s rental market. Indeed, fresh imbalances between rental supply and demand are building in the capital. We expect rents to rise faster in the coming years, perhaps by 3.5% in 2020 and 5% y/y in 2021.
  • So, with tenant demand picking up and supply unable to keep pace, we expect rental growth to pick up over the next couple of years. (See Chart 61.) In all, we expect rental growth to rise by a modest 1.5% this year, before quickening to 2.5% in 2020 and to 3.5% in 2021. (See Chart 62.)
  • Of course, this is predicated on a no deal Brexit being avoided. Admittedly, we don’t expect rents to decline by much if there was a no deal. After all, during the financial crisis rents only fell by around 2%. And, if there is an aggressive policy response, any recession following a no deal Brexit will most likely be shallower and shorter than most predict.
  • However, we don’t think that faster rental growth will drive a meaningful improvement in landlords’ returns. (See Chart 63.) After all, slow house price growth will keep capital gains subdued and, if a deal is struck, mortgage costs are set to increase in line with tighter monetary policy. That suggests the BTL sell off may have further to run.

Residential Lettings Market

Chart 57: Growth in Rents (% y/y)

Chart 58: Tenant Demand and Landlord Instructions

Chart 59: Mortgage Payments and Rents as a % of Full-Time Disposable Earnings (Brexit Delay Scenario)

Chart 60: Private Sector Rental Growth
and Earnings (% y/y)

Chart 61: England Rents and Lettings Supply & Demand Balance

Chart 62: Rental Growth & Total Returns

Chart 63: Mortgage Interest Rate and Gross Rental Yields (%, Brexit Delay Scenario)

Chart 64: Total Returns on Property (%)

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Sources: VOA, RICS, DCLG, UK Finance, Refinitv, Capital Economics


Housing Supply

Early signs of construction drop

  • Housing construction has dropped off recently. Granted, completions reached 45,200 in Q2, a post-crisis high. But housing starts fell for the third consecutive quarter, pushing the pace of construction down to its lowest level in three years. (See Chart 65.) And with the HTB scheme set to be pared back, the outlook for housebuilding is muted.
  • The recent survey data have been subdued. The IHS Markit/CIPS housebuilding activity index weakened from 48.0 in August to 47.7 in September, the fourth consecutive decline in activity. (See Chart 66.) And the HBF survey reported that net reservations were down, in line with the ongoing decline in the use of sale incentives. (See Chart 67.)
  • In recent years, a shortage of labour and materials has limited housing construction. However, these appear to have eased. Indeed, the proportion of builders reporting labour and material availability as key constraints on construction has waned in recent months. (See Chart 68.)
  • More recently, Brexit uncertainty has forced housebuilders to take a more cautious stance. And that has been amplified by an ongoing weakness in demand for houses. Indeed, the HBF survey recorded a further decline in site visits and new registrations compared to the previous year. (See Chart 69.)
  • The ongoing deterioration in demand is partly the result of exceptionally high house prices, particularly in the capital. London has led the decline in housebuilding, where starts fell by over 21.5% y/y in Q2.
  • However, at 0.5% q/q in Q3, Nationwide’s measure of house price inflation suggests prices have increased at a subdued pace across the country. That suggests that housing starts will remain soft. (See Chart 70.) Admittedly, the relationship is not perfect. But, the past sluggish house price growth has been consistent with slower housing starts too.
  • More recently, and perhaps more concerning is that the slump has become more broad-based as construction fell in nearly every region in Q2. (See Chart 71.) In particular, the Midlands, the South and East of England each saw starts fall by between 8% and 9% in the year to Q2. And together, the regions in the North of England saw a sizeable 6.6% y/y fall.
  • This probably reflects prolonged Brexit uncertainty. Looking ahead, if there a Brexit deal was agreed soon, the decline in construction should partly reverse over the following months. If that is the case, housebuilding could receive a small boost in early-2020.
  • However, we only expect a limited rebound over the medium term. That’s because the HTB scheme is set to be pared back in 2021, and completely withdrawn by 2023. HTB has propped up demand for new homes. That can be seen in the housing starts data which have grown more strongly than the historic relationship with transactions would usually suggest. (See Chart 72.) In turn, housebuilders’ construction plans will most likely be hit in the middle of next year, as homes tend to take around two years to complete.
  • If, as seems likely, a no deal Brexit is avoided, we expect starts to fall by around 1% a year on average until 2021. However, if there were a no deal Brexit, there would be a sizeable dip, as housebuilders respond to a slump in transactions.

Housing Supply

Chart 65: DCLG Housing Starts & Completions (000s)

Chart 66: IHS Markit Construction PMI

Chart 67: Builders Reporting a Rise in the Use of Incentives & Net Reservations

Chart 68: Builders Reporting Constraints on Buyer Demand (%)

Chart 69: Builders Reporting a Rise in Net Reservations and Site Visits

Chart 70: Housing Starts and House Price Growth

Chart 71: Housing Starts by Region

Chart 72: Housing Starts and Transactions
(000s, 4q Rolling Total)

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Sources: MHCLG, ONS, HBF, NHBC, Refinitiv, Capital Economics


Andrew Burrell, Chief Property Economist, 020 7811 3909, andrew.burrell@capitaleconomics.com
Hansen Lu, Property Economist, 020 7808 4988, hansen.lu@capitaleconomics.com
Gabriella Dickens, Assistant Economist, 020 3974 7421, gabriella.dickens@capitaleconomics.com